A commodity currency is a name given to some currencies that co-move with the world prices of primary commodity products, due to these countries’ heavy dependency on the export of certain raw materials for income.
Commodity currencies are most popular in developing countries such as Burundi, Tanzania and Papua New Guinea. However developed countries like Canada and Australia can also have this type of currency. For example, the Canadian Dollar grows stronger, the higher the price of soybeans and oil because these are Canada’s two major commodities.
In the foreign exchange market, commodity currencies generally refer to the Australian dollar, Canadian dollar, New Zealand dollar, Norwegian krone, South African rand, Brazilian real, Russian ruble and the Chilean peso.
Due to the nature of commodity currencies being tied to commodities, being tied to any one good can be beneficial as well as problematic for the country. While naturally, falling or rising exports will lead to deflation or inflation respectively in any country the impacts are more severe in countries with commodity currencies at their currency is so heavily tied to a set few commodities.
A currency that is naturally tied to a country’s major commodities can be beneficial if the global demand for a commodity increases, naturally strengthening the value of the currency. This increased demand also is likely to increase GDP as more exports take place.
But commodity price shifts will not affect all nations, or their currencies, in the same manner. After all, nations with moderate supplies of a commodity will not have their currency affected as greatly by price shifts as nations who have little to no supply of their own.
In the same vein, for example, nations who have vast oil supplies and who therefore have a significant portion of their economies tied to crude prices will see strong correlations between commodity prices and their currency exchange rate.
When the domestic economy is greatly affected by commodity price shifts, then the currency is especially vulnerable. Even for nations whose currency is strongly correlated with commodity pricing, different commodities will affect the currency differently (or perhaps not at all).
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